College of Business
News

November
6, 2002 -- News Brief

Reverse
Stock Splits Making News: Ikenberry Study Cited

Research by
David Ikenberry, professor of finance, was cited recently by both the Wall
Street Journal and the New York Times. Ikenberry and and Sundaresh
Ramnath, assistant professor of accounting at Georgetown University, collaborated
on a theory
about reverse stock splits that was published earlier this year by The
Review of Financial Studies.

Ikenberry and
Ramnath's study was cited by Dennis Berman in the October 21 edition of the
WSJ in an article focusing on Lucent Technologies announcement that it was considering
a reverse stock split to increase its share price from 68 cents per share to
over $1. Lucent considered this move to prevent the company from being "delisted"
on the New York Stock Exchange. Ikenberry was quoted as saying that such a move
"confirms investors's fears that the possibility of raising the stock price
naturally is not going to happen."

In the November
3 edition of the Times, Ikenberry and Ramnath's study is cited as the
source of a theory about the "confidence factor" in reverse stock
splits. Mark Hulbert was covering plans for reverse stock splits announced by
Lucent Technologies and Nortel Networks and a split implemented in mid-October
by Palm, Inc. Hulbert cited the work by the research team, who postulated that
when management is not optimistic about a stock's future performance, a reverse
split is often used to increase the price per share. When management is optimistic
that the extremely low price per share will eventually rise, the stock is left
alone.

An emerging literature
looking at self-selected, corporate news events concludes that markets
appear to underreact to news. Recent theoretical articles have explored
why or how underreaction might occur. However, the notion of underreaction
is contentious. We revisit this issue by focusing on one of the most simple
of corporate transactions, the stock split. Prior studies that report
abnormal return drifts subsequent to splits do not appear to be spurious,
nor a consequence of misspecified benchmarks. Using recent cases, we report
a drift of 9% in the year following a split announcement. We consider
fundamental operating performance as a source of the underreaction and
find that splitting firms have an unusually low propensity to experience
a contraction in future earnings. Further, analysts' earnings forecasts
are comparatively low at the time of the split announcement and revise
sluggishly over time. Together these results are consistent with the notion
of market underreaction to the information in corporate news events.